Understanding Your Risk Appetite Before Investing in Mutual Funds

A viewer on our YouTube channel asks, “Sir, How can I identify my risk appetite? Please let me know the points to consider when deciding asset allocation. Thanks.” Many investors believe their risk appetite falls under three categories: low, medium and risk. They also assume risk appetite refers to “how much risk we can handle”. Both these notions are incorrect.This investment risk appetite question bears an interesting resemblance to students’ exam approach. At the beginning of each semester, I inform my class that grades don’t reflect intelligence. Instead, they indicate the effort and time management a student has dedicated to meeting the system’s requirements. Grades cannot measure intelligence. See: Do marks determine the future of our children? The system may not be perfect, but to earn the right to complain about the system, the student should comply with it as best he can.Similarly, investment risk appetite cannot be quantified. Although expensive questionnaires with objective questions like “What will you do if the stock market crashes by 50%” exist, they are easy to answer because the option “invest more and hold for the long term” seems like a clear choice, especially without real-life experience. Note: SEBI requires these questionnaires for registered investment advisors to work with clients. So right/wrong/inadequate, it is a regulatory requirement.So what does the risk appetite represent? It is a measure of well we understand the following:Where we stand wrt our finances (A) and where we need to go (B), and what we need to do about it (the path from A to B).What can go wrong in the path from A to B, and how well can we manage risk?What are the pros and cons of each investment product that we choose?In other words, risk appetite is not a measure of how much risk we can take. It is an appreciation of how much risk we should take. Risk appetite = risk awareness.No one can measure how much risk we can take with a set of questions. We can measure our understanding of the risk we must take with a set of (different, relevant and personalised) questions.So, how can we identify our risk appetite before investing in mutual funds or even a fixed deposit? In other words, how can we become risk-aware?Identify our future needs.Understand how inflation impacts these needs.How can we create a portfolio that overall (debt + equity) provides a return close to inflation after tax?Most people, except those with extremely high incomes, must have 50-70% equity in their long-term portfolios. However, most individuals possess debt-laden portfolios and limited experience in the capital market, resulting in a significant disparity between the risk they should and can take. Someone with no equity experience should not immediately invest 50% or more of their available funds into equity.Instead, investors should consider gradually investing in equity mutual funds (or stocks), beginning with 10% of their total monthly investment and slowly increasing this allocation over time. As experience grows, so does the ability to handle market fluctuations, and individuals can become more comfortable with the appropriate level of risk. Determining risk appetite is an ongoing process.In contrast, some individuals, particularly senior citizens, may want to take on more risk than they can handle. Unlike younger do-it-yourself investors, they may not have the luxury of time, making professional advice valuable.Those requiring professional advice can consult a SEBI-registered fee-only investment advisor from our curated list. Those who wish to DIY can get started here to understand how you can become risk-aware: Basics of portfolio construction: A guide for beginners.List of points to consider while deciding asset allocation:When is the money required?Reasonable inflation and return expectations from equity and fixed income after tax.How much money can I invest? The above inputs will help you decide on the asset allocation. You can use our Robo advisory tool to automatically determine the correct asset allocation for your goals and how to vary it in future to reduce risk.If there is a difference between the money I can invest and the money I should invest (calculator output), how can we arrive at a compromise? This is a tough step, and not all DIYers would get it right. If you need help, consult a SEBI-registered fee-only advisor from our list.What is my current asset allocation? How long would it take to reach the desired allocation? What is my strategy to get there? Again a fee-only advisor can make a big difference here.In summary, it is best if investors don’t assume they know their risk appetite or try to determine it with a quiz. Getting used to capital market risk is a process and can be subject to recency bias.It would take a few market cycles and consistent investing to get used to the volatility. In the meantime, investors should strive to become risk-aware. That is, they should appreciate what is required to meet future expenses and remind themselves of this if their conviction wavers. Do share this article with your friends using the buttons below. 🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users! Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1000 investors and advisors use this! New Tool! => Track your mutual funds and stocks investments with this Google Sheet!Follow Freefincal on Google NewsSubscribe to the freefincal Youtube Channel. Podcast: Let’s Get RICH With PATTU! Every single Indian CAN grow their wealth! Listen to the Let’s Get Rich with Pattu Podcast You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.Lets Get RICH With PATTU podcast on YouTubeDo you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincalHave a question? Subscribe to our newsletter with the form below.Hit ‘reply’ to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question. Join over 32,000 readers and get free money management solutions delivered to your mailbox! Subscribe to get posts via email! Explore the site! Search among our 2000+ articles for information and insight!About The Author Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice. Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter what the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence. Our new course!  Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts you and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!    Our new book for kids: “Chinchu gets a superpower!” is now available!Both boy and girl version covers of Chinchu gets a superpower. Most investor problems can be traced to a lack of informed decision-making. We have all made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it and teach him several key ideas of decision-making and money management is the narrative. What readers say!Feedback from a young reader after reading Chinchu gets a Superpower!Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. – Arun. Buy the book: Chinchu gets a superpower for your child! How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only! Want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or you buy the new Tactical Buy/Sell timing tool! We publish monthly mutual fund screeners and momentum, low volatility stock screeners. About freefincal & it’s content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained) Connect with us on social media Our publicationsYou Can Be Rich Too with Goal-Based Investing Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.Your Ultimate Guide to Travel This is an in-depth dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)  


Recommended For You